Smaller SaaS More Vulnerable than Larger in 2020

June 25, 2020

What a difference a few months makes!  Back in January, 2020 looked so different. By early 2020, investment in the SaaS industry was at record highs and expected to hit even higher peaks.  In early Feb., TechCrunch wrote that VCs were putting an extra $1B into SaaS in 2020, in fewer deals, so more money per company.  2019 saw a record-breaking VC exit value of over $250 billion, according to the NVCA’s Venture Monitor’s Q4’19 report.  

I wrote a blog that asked whether an avalanche of VC and PE capital would impact 2020 budgets.  Investors were competing aggressively for deals and growing SaaS budgets had companies spending significantly over revenues to acquire subscribers, market share and build new or expanded products.  Remember T2D3?Fast forward to today, mid-June 2020.  Cash runway and P&L strength are the focus of investors and SaaS management alike.   Private SaaS investors are telling companies to manage cash and extend their cash runway, while investors in public companies are looking at companies’ balance sheets to see how they’ll be able to weather an extended economic disruption.   There’s still a lot of available capital, and SaaS remains one of the best performing sectors in the economy.  However, the ripple effects from the rest of the economy have slowed growth for most companies and makes cash flow an even more important metric to stress test whether a company can manage thru the current changing environment.

How Did SaaS Companies Look Financially Coming into the Covid Economic Crisis?

We compared benchmarks for smaller and larger private SaaS companies coming into 2020, against the same metrics five years ago in our 2015 benchmarking and focused the comparison on cash flow.

Smaller, growth SaaS companies (revenues between $10M-$20M) as of the beginning of 2020 had dramatically worsened both cash from operations and EBITDA over the past five years.  Median net cash from operations had been reduced 5X times since 2015 for smaller SaaS companies.  And median EBITDA had worsened 3X over the same time period.  The majority of smaller private SaaS companies were spending far more than they were earning in subscriptions by early 2020, most likely due to the easy availability of investor and other capital – and the pressure to grow at all costs with 3-digit growth rates.

At the same time, larger, private SaaS companies had already pulled up the reigns on spending by early 2020 and looked financially stronger than the same stage companies did five years ago.  Median net cash from operations and EBITDA for SaaS with revenues between $50M-$100M were approaching cash flow breakeven and profitability coming into 2020.The other side of the investor pressure to spend in order to grow fast is increased pressure for SaaS companies to get to cash flow breakeven faster than earlier generations.  Bessemer published a growth benchmark showing that getting to $100M ARR in 10 years was good, but getting there in 5 years is best in class.

The good news is that there are now more positive EBITDA SaaS companies with $100M+ ARR run rates than ever before.  These larger private SaaS companies are in a better position to weather the Covid crisis than companies spending 3 to 5 times more cash than they are producing in sales.These benchmarks are all based on the SaaS sector as a whole at various revenue sizes.  Of course, any company, whether large or small, selling to markets most directly impacted by Covid, such as travel, airlines, and restaurants, will be hard hit regardless of their financial strength coming into 2020.  And smaller SaaS companies with products supporting the new normal of remote working/learning and social distancing may not need to worry about their cash runway when sales are actually increasing in Covid times.

Key Take-Aways

Clearly, the financial models based on easily available capital are not the ideal model for the current uncertain economic situation.  We see SaaS companies and investors focusing more on cash flow, timeline to profitability and efficiency of operations than ever before.

At a time when it is harder to close new deals, and sales cycles are lengthening for the majority of companies, attention is turned to retaining customers and reducing churn.  Company valuations will be even more closely tied to cash flow, customer retention, and profitability.  As has been said many times before, SaaS companies have only two ways to grow – through new customer acquisition and through improved retention of customers and customer contracts.  The cost of retaining customers should always be less than the cost of acquiring a new customer.  The Rule of 40 still applies, but the extreme weighting of revenue growth rate over profitability is expected to even out.We see SaaS companies becoming even more focused on analytics.   Benchmarks for resource allocations, profitability and management of tech’s greatest asset – human resources – are shifting.For the most part, SaaS companies are better positioned than the rest of the economy by the very nature of cloud-based products and operations in a remote-work world.  The data-driven and entrepreneurial culture of SaaS companies helps SaaS companies evolve quickly and dial down risk.   It will be an interesting year all around.